1

2000 Annual Report

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Financial Highlights . . . . . . . . . . . 1

Letter to Stockholders . . . . . . . . . . 2

AAR At-A-Glance . . . . . . . . . . . . 18

Board of Directors . . . . . . . . . . . . . 20

Financial Review . . . . . . . . . . . . . . 21

Stockholder Information . . . . . . . 43

Board Committees . . . . . . . . . . . 44

Corporate Officers . . . . . . . . . . . 44

contents

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financial highlights

(000s omitted, except per share data)

for the year ended May 31, 2000 1999 1998 1997 1996

Operating Performance

Total sales* $1,024,333 $1,050,608 $856,637 $633,553 $549,967

Net income 35,163 41,671 35,657 23,025 16,012

Net income per share—diluted $ 1.28 $ 1.49 $ 1.27 $ .91 $ .66

Financial Position

Working capital $ 347,451 $ 334,600 $319,252 $314,119 $258,627

Total assets 740,998 726,630 670,559 529,584 437,846

Total debt 206,761 181,359 177,746 118,292 119,766

Stockholders’ equity 339,515 326,035 300,850 269,259 204,635

*Includes pass through sales

to our stockholders: Fiscal 2000 was a year of mixed results for our Company.

Revenues for fiscal 2000 exceeded those of any year in the Company’s history,

however, net income declined from the prior year. Our earnings through the first

nine months of the year were ahead of fiscal 1999 by nearly 10 percent. As our

fourth quarter unfolded, the business environment was impacted by rising interest

rates and fuel prices, leading to customer delays in purchasing big ticket items,

in particular aircraft and engines. This, together with lower than expected sales

to certain inventory program customers, led to lower results in our March to May

period. Throughout the year, we generated positive cash flow from operations and

continued to invest in new capabilities and technology.

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David P. Storch, President and Chief Executive Officer

“We continue to refine our ‘close to the

customer’ business model and to build our

franchise as a value-added provider of high

quality products and services to the global

aviation/aerospace industry.”

Revenues, before pass through sales, grew to a record $957.5 million compared to $918.0 million in fiscal 1999. Net income

declined to $35.2 million from $41.7 million the prior year, and we reported diluted earnings per share (EPS) of $1.39, down

from $1.49 a year ago. Including the charge to increase bad debt reserves, EPS for fiscal 2000 was $1.28.

The AAR team is working to strengthen our position in a number of markets. Although fourth quarter results for our aircraft

and engine sales and leasing businesses were disappointing, we have been leaders in the engine market for many years and have

recently re-established ourselves as a niche player in the aircraft market. These are very opportunistic businesses, and with our

experienced leadership team, market knowledge and financial resourcefulness, we expect to capitalize in this dynamic market.

Three years ago, AAR entered the new parts distribution business with the acquisition of Cooper Aviation followed shortly there-

after with the purchase of AVSCO, forming AAR Distribution. We bought these businesses to enhance our product offerings to

our airline customers and to enter the business and general aviation markets. Since these acquisitions, our commercial aviation

distribution business has achieved a 24% compounded annual growth rate while our general aviation business has not met our

expectations. To address this, in the first quarter of fiscal 2001, we announced steps to streamline our U.S. distribution network to

coincide with the launch of our more robust general aviation web site, allowing customers to research parts from our extensive on-

line catalog, place orders 24 hours a day from anywhere in the world, check their order status and learn about special promotions.

During fiscal 2000, the Company benefited from strong growth in the regional jet market as well as from military outsourcing.

Our component repair businesses and landing gear business supporting regional aircraft grew 44% while our sales to military

customers of repair services grew 41%. We made additional investments in landing gear to support our regional jet customers

including support for the popular Canadair Regional Jet. We also expanded our component repair facilities and capabilities to

support new products including environmental control systems, power control units and electrical systems.

The accomplishments we achieved in fiscal 2000 strengthen our franchise as our 2,800 strong employee team implements the

below-referenced initiatives. Significant fiscal 2000 highlights include:

• AEROSPAN.COM, a joint venture with SITA, was created to establish the most comprehensive electronic marketplace for

the air transport industry. By web-enabling airline purchasing departments, AEROSPAN.COM will provide global access

to the wide array of products and services within the air transport universe in a highly efficient processing environment.

• All of our major manufacturing, overhaul, supply and repair business units completed ISO 9000 certification reflecting

our unwavering commitment to operational excellence and high quality standards.

• Our AAR Allen Aircraft operating unit was selected by Honeywell as the sole distributor of its Hydro Mechanical Unit

(HMU) for the CFM56-7 engine. The CFM56-7 engine powers Boeing’s 737 “next generation” aircraft. There are approxi-

mately 480 of these 737s in service with an additional 887 next generation 737s on order.

• We opened and expanded the following repair facilities:

– AAR Wheel & Brake Services opened facilities in Dallas, Texas and Miami, Florida to provide repair services for

commercial, regional, military, business and general aviation aircraft.

– AAR Landing Gear Services expanded its facility in Miami, Florida to accommodate additional bushing manu-

facturing and hydro-mechanical actuator repair.

– AAR Aircraft Component Services expanded its facility in Garden City, New York to support increased demand

for outsourced repair requirements from U.S. military customers.

– AAR Cargo Systems opened a new FAA-certified repair station in Memphis, Tennessee increasing our cargo

component repair business.

– AAR Aircraft Services’ facility in Roswell, New Mexico received FAA certification to provide limited airframe

maintenance, storage and tear down services.

The airline transportation industry is a $100 billion market, and the worldwide aerospace industry is a $500 billion

market. The sky is the limit, and we have the entrepreneurial spirit and financial strength to reach for the sky.

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We continue to refine our ‘close to the customer’ business model and to build our franchise as a value-added provider of high

quality products and services to the global aviation/aerospace industry. We have a number of initiatives underway pertaining to

sales growth, margin expansion, operational excellence and working capital efficiency:

• We are expanding our position in aircraft and engines for sale or lease, utilizing a variety of financing alternatives

including joint ventures, leveraged leases, operating leases and existing bank lines.

• We are capitalizing on our industry-leading logistics and supply chain knowledge to expand our inventory and

maintenance support programs.

• We are stepping up our investment in FAA-authorized parts manufacturing authority (PMA) to offer our customers

quality products at competitive prices.

• We are increasing the emphasis on engineering content in our repair processes.

• We are leveraging our investments in our e-business platform to expand sales.

As you read this year’s annual report, you’ll see that we are expanding the depth, breadth and reach of AAR as we look to gain

market share. While we have taken steps to reduce our cost structure, our team is committed, now more than ever, to improving

customer satisfaction and financial performance.

We anticipate our business environment will remain challenging in the near term. Consolidation is occurring at both the customer

and supplier levels. The major aviation original equipment manufacturers (OEMs) view the services sector as important to their

growth strategy and, in some instances, view AAR as a friend and ally, and in others, as a competitor. Many of our direct com-

petitors are struggling financially and, during the year, two of our airline customers filed for bankruptcy protection. Our business

continues to benefit from the increase in the worldwide fleet of commercial and regional aircraft and from an increase in

outsourcing opportunities in support of the U.S. government.

I believe our strategy of providing a broad array of products and services to the global aviation community which has served our

company well in the past, will continue to do so in the future. Additionally, the diversity of our customer base, which includes

large U.S. and international airlines, regional carriers, start-up airlines, freight carriers, OEMs, governments, business and general

aviation operators, creates a balanced portfolio allowing us to focus our resources on those markets with the greatest demand.

As we venture forth, I would like to express my appreciation to the employees of AAR for their hard work and dedication to

excellence. I would also like to acknowledge the contribution of our Board of Directors for their guidance and wisdom imparted

to our leadership team. And, I would like to thank you, our shareholders, for your continued support.

Sincerely,

David P. StorchPresident and Chief Executive Officer

AAR provides customers with the most extensive array of product and service offerings in the aviation/aero-space industry. Equally important, we have the depth—the marketing, technical and financial expertise, and thepeople—to back those products and services. Our depth enables us to do things right for our customers—the firsttime, on time, every time.

d

moving into new opportunities and

One way to pick a winning team is to look at the depth of their bench. AAR’s depth starts with our people.

We have a highly skilled workforce, 2,800 strong, available 24 hours a day, worldwide, year-round. Add to that

a unique combination of marketing, technical and financial expertise that enables us to enhance customer com-

petitiveness and ensure customer satisfaction. Our culture of quality demands every employee does things

right—the first time, on time, every time. Proprietary inventory information systems allow us to source,

procure, trace, track and sell inventory for a broad array of aircraft types—commercial, military and private.

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Taken together, our people, expertise and emphasis on quality give us the ability to support the major air carriers, business jet

operators, original equipment manufacturers and governments in helping them become more efficient and reduce their costs

while continuing to emphasize safety. At AAR, safety of flight is paramount to everything we do. We also have the ability to apply

all of AAR’s resources to support smaller airlines as well as start-up airlines in providing the type of sourcing, planning and systems

they would not normally be able to afford on their own.

But we’re not content to stop there. We’re going to get even better. We have several operational excellence initiatives in place,

including training in Continuous Improvement. We are also implementing a Customer Loyalty Measurement System to learn

how customers view our business and identify steps we need to take to better help customers meet their goals. At our foundation is

AAR’s financial strength. We have been in business for almost 50 years and have been profitable every year—even during industry

down cycles. We will be here when our customers need us with the financial resources to put into effect the innovative programs

that we create on their behalf. Our goal is to continue to create value for customers, stockholders and employees, and in doing

so, maintain AAR’s industry leadership position.

building long-term relationships,

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AAR has a unique portfolio of businesses providing everything from parts (whether a simple light bulb or a com-plex cockpit computer) to supply chain management (including online inventory control systems and turnkeymanagement of the entire supply chain) to the maintenance of customer aircraft.

Because we provide so many products and services, customers look to AAR when they need solutions. We’re up tothe task. Our goal is to develop integrated programs for our customers that exceed their expectations and providethem with the convenience of one company for all their product and support needs.

meeting customers’ needs and AAR started out as a broker of used aircraft radios. Over the years, we have grown to become one of the

largest parts suppliers in the industry. Today, customers want more. They want to focus on what they do

best—flying aircraft. And we help them by doing what AAR does best—everything else. Today, AAR has an

extensive selection of products and services to meet customer needs when it comes to parts, supply chain

management, component service and aircraft maintenance. These offerings help our customers become more

successful by increasing efficiency and reducing costs.

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expanding products & services,El Salvador-based GRUPO TACA, for example, wanted help managing its parts inventory and maintenance operations. We

responded with a customized program. Now, instead of buying parts and services for certain aircraft individually from numerous

suppliers with multiple purchase orders and repair orders, TACA saves time and money by outsourcing this function to AAR.

In a move that expands AAR’s maintenance and overhaul capabilities, AAR Aircraft Services’ facility in Roswell, NM received

FAA certification to provide limited maintenance and storage services for aircraft including Airbus A300 and A310; Boeing 727,

737 and 747; Douglas DC-9, MD80, DC10 and MD11; and Lockheed L1011. Because Roswell offers access to U.S. Customs,

Immigration and Agriculture services, international customers can fly nonstop into the facility avoiding costly clearance stops

that incur landing fees, unscheduled maintenance, fuel and crew costs.

And of course, AAR still does a better job than anybody else when it comes to supplying parts to customers. New customer-

specific e-Business offerings such as our Commercial Aviation, General Aviation and Military & Government sites will make it even

easier for customers to get the products and services they need when they need them. In addition, our Strategic Allies Program

allows rapid deployment customers to order complementary items from other companies through our Military & Government site.

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AAR counts the finest companies in the world aviation industry among its customers: U.S. and internationalairlines, regional airlines, cargo carriers, manufacturers of aerospace products and systems, independent over-haulers and governments around the globe. Our mission is to be the industry leader and innovator in providingaviation products and services in the global electronic marketplace.

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growing in IT capabilities and AAR has always made it a priority to stay in touch with customers and their changing needs. Now through

major investments in new systems, technology and e-commerce initiatives, we are reaching out to expand

our customer base and increase loyalty among existing customers. Through AAR Online Services programs,

such as our customer-specific Commercial Aviation and General Aviation sites (which provide access to an

extensive inventory of new, overhauled or serviceable components) and Online Partner ServicesSM (which

allows our inventory management customers to view the status of inventory, purchase and repair orders), we are

providing our customers with cutting-edge, web-based business solutions.

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spanning the world wide webWe provide similar services to military customers through our Military & Government site and Strategic Allies Program.

Each of our customers has access to our very extensive database. Customers also have the opportunity to create additional

efficiencies and further reduce costs by accessing our web-based systems.

In a significant joint venture that will open up new sourcing channels and reduce procurement costs for industry participants,

AAR and SITA are working together to launch AEROSPAN.COM, a comprehensive electronic marketplace for the air-transport

industry. By web-enabling airline purchasing departments, AEROSPAN.COM will provide global access to the wide array of

products and services in a highly efficient processing environment.

Customers who use AEROSPAN.COM will have opportunities to achieve increased operating efficiencies through industry-

specific functionality and features to automate, streamline and simplify their business processes.

Airframe & Accessories

Aircraft Sales & Leasing. Airlines are constantly changing the com-position of their fleets. Whether an airline needs to purchase, lease,sell, or trade aircraft, AAR provides unparalleled service, includinglocating, evaluating and acquiring aircraft; performing or managingrequired maintenance, upgrades and conversions; facilitating aircrafttrades (buy or sell); structuring operating leases; purchasing existingleases; and providing innovative financing solutions.

Engine Sales & Leasing. AAR maintains a sizable inventory ofengines that meets customers’ exact specifications. Our portfolioincludes engines from the world’s most respected manufacturers,including CFM International, General Electric, International AeroEngines, Pratt & Whitney and Rolls Royce. Customers can choosefrom a variety of purchase, variable-term lease and exchange programsthat meet both their short- and long-term needs.

Engine Parts Supply. AAR is the aviation industry’s largest independ-ent supplier of aircraft engine components and inventory managementservices designed to reduce maintenance costs and increase efficiency.We offer a full range of engine parts services, including parts supply,just-in-time delivery, repair and exchange, onsite warehouse manage-ment and inventory management.

Engine Component Repair. AAR provides turbine engine componentoverhaul for aircraft operators, independent overhaul facilities andpower generation companies. Our capabilities also include on-siteoverhaul of industrial steam and gas turbines, replacement parts, bladeand valve repair, installation of erosion shields, diaphragm and nozzlecoatings, and rotor overhaul and balancing.

Aircraft Maintenance, Modification and Services. AAR providesmajor maintenance inspections, line maintenance, aircraft modificationsand upgrades to the world’s major, regional and cargo airline fleets, andthe U.S. military and government agencies. Our facility in OklahomaCity has over 200,000 square feet in seven hangars to support six “nose-to-tail” narrow-body aircraft maintenance lines.

Aircraft Component Repair. AAR services rotable components withAOG service, 24 hours a day, 365 days a year, at facilities in Amsterdam,London and New York, where we repair, overhaul and maintain morethan 22,000 parts including avionics, instruments, pneumatics, hydraulics,electronics, fuel controls and electrical accessories.

Landing Gear Repair. AAR specializes in the exchange and overhaulof landing gear for all commercial aircraft and, through its subsidiary,AAR Tempco, all regional aircraft. Additional capabilities include bushingmanufacturing and hydro-mechanical actuator repair.

Airframe Parts Supply. AAR offers a vast inventory of new andrefurbished airframe parts for virtually every commercial aircraft type.We also provide inventory management and exchange programs thathelp customers reduce costs, increase parts availability, reduce leadtimes and ensure quality.

Distribution. AAR provides high-quality, factory-new products to theworldwide commercial, general and business aviation markets. We stockover 35,000 items from over 250 aviation equipment manufacturers,providing customers with expert sales staff, same-day shipping and fullcoverage of the market from private aircraft to jumbo jets.

AAR’s repair operations encompass a broad range of capabilities

including aircraft and landing gear maintenance and airframe and

engine component repair and overhaul. Our focus is on extending

on-wing performance and reducing downtime.

Continued growth in worldwide passenger and air cargo

traffic means ongoing growth opportunities for AAR’s

Aircraft and Engine Group.

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Aircraft & Engines

AAR At-A-Glance: Comprised of 2,800 employees at 40 facilities located in 12 countries, AAR is one of the

world’s largest and most diverse aviation aftermarket support companies. Since our founding in 1951, we

have grown by anticipating customer requirements in this very competitive market, developing innovative,

cost-effective products and programs, and delivering on a commitment to do things right.

Manufacturing Technology

Cargo Loading Systems. AAR designs and manufactures in-aircraftcargo loading systems known for rugged durability, high reliabilityand customized features. Customers rely on us to develop innovativesystems that maximize cargo transportation efficiencies.

Rapid Deployment Support Products. AAR offers rapid deploy-ment support products for use by branches of the U.S. military.Significant products include transportable shelters for varied uses inthe field, as well as containers ranging from small weaponry carriers to room-sized, self-powered refrigerated units suitable for medicalsupplies. In addition, our Strategic Allies Program allows rapiddeployment customers to order complementary items from othercompanies online through our Military & Government web site.

Composites. AAR provides design, engineering and manufacture ofcomposite interior and exterior structures for the aerospace industry.We specialize in aircraft interior modifications that reduce noise,increase cabin space and extend the service of aircraft componentsthrough superior durability, strength and noncorrosive characteristics.

AAR is committed to being on the leading edge of IT solutions for our customers. Our Enterprise Resource Planning systems are state-of-the-art supply chain applications that provide enhanced customerservice and allow for more efficient business processes. AAR OnlineServices customer-specific web sites allow our Commercial Aviation,General Aviation and Military & Government customers to checkavailable inventory and services and order online. Meanwhile, OnlinePartner ServicesSM offers information to participants in our long-terminventory management programs, including tracking purchase orders,repair orders and material requisitions. This system is capable ofreflecting a customer’s on-shelf inventory as well as consigned andavailable inventory.

The introduction of these services means significantly increased speedin transaction processing, more accurate and timely information onorder status, and access to pertinent information without regard toglobal time zones. Our goal is to communicate with customers on theirterms and make it easier for them to do business with us.

AAR designs and manufactures onboard cargo systems for

military and commercial aircraft, rapid deployment support

products for the U.S. and other governments, and composite

structures and components for aircraft manufacturers and

modification/repair centers.

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Significant investments in information technology (IT) bring the

highest quality product and overhaul capabilities to our customers

faster and more economically.

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board of directors(pictured back row to front row, left to right)

A. Robert AbboudPresident, A. Robert Abboud & Co.

Edgar D. JannottaSenior Director, William Blair & Company, L.L.C.

Lee B. SternPresident, LBS Co.

Joel D. SpunginManaging Partner, DMS Enterprises, L.P.Chairman Emeritus of United Stationers, Inc.

Erwin E. SchulzeChairman Emeritus, Chicago Stock ExchangeRetired Chairman of the Board, Ceco Industries, Inc.

Ira A. EichnerChairman of the Board and Founder, AAR CORP.

Howard B. BernickPresident and Chief Executive Officer, Alberto-Culver Company

David P. StorchPresident and Chief Executive Officer, AAR CORP.

Richard D. TaberyAviation Business Consultant

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RESULTS OF OPERATIONS

The Company reports its activities in one business segment:

Aviation Services. The table below sets forth sales for the

Company’s classes of similar products and services within this

segment for each of the last three fiscal years ended May 31.

for the year ended May 31, 2000 1999 1998

Sales:

Aircraft and Engines $ 440,502 $ 416,196 $339,299

Airframe and Accessories 397,090 376,259 333,283

Manufacturing 119,933 125,581 109,541

957,525 918,036 782,123

Pass through sales 66,808 132,572 74,514

$1,024,333 $1,050,608 $856,637

Three-Year Sales Summary

Over the last three fiscal years, consolidated sales, before pass

through sales, increased from $782,123 in fiscal 1998 to

$957,525 in fiscal 2000. Total sales, which include pass through

sales, increased from $856,637 in fiscal 1998 to $1,024,333 in

fiscal 2000. The growth in sales was the result of the growing

demand for the Company’s broad line of products and services

in the aviation/aerospace market, whose rate of growth declined

slightly the last two fiscal years. In fiscal 1998, most of the

world’s major airlines, excluding those in Asia, reported record

or near record operating earnings driven by strong revenue

growth and their various initiatives to control costs. In 1999

and 2000, however, many of the world’s airlines experienced

lower operating earnings compared to 1998 reflecting slower

revenue growth and higher expenses. Certain domestic aviation/

aerospace original equipment manufacturers also experienced

lower operating earnings during the latter half of the three-

year period reflecting the overall softening aviation/aerospace

market. In addition, during the latter part of the three-year

period, many airlines replaced older aircraft, such as the 727 and

DC-9, powered by the JT8D engine family, and older 747s,

generally powered by the JT9D engine family, in favor of

newer aircraft, such as the 737-300, 747-400, 777, A320 and

A330/A340. The Company continues to develop new repair

and overhaul capabilities and other support programs for the

newer generation aircraft and engines.

During fiscal 1998 and 1999, the Company’s sales before pass

through sales benefited from the aggressive pursuit of market

opportunities in the relatively strong aviation/aerospace market.

Sales in Aircraft and Engines benefited from new inventory man-

agement programs and higher sales of its aircraft and engine

sales and leasing products. Sales in Airframe and Accessories

increased as a result of greater demand for the Company’s

repair and overhaul services and the impact from the acquisi-

tion of a new aircraft parts distribution company during 1998.

Sales in Manufacturing increased in 1999 compared to 1998

from strong demand of the Company’s products supporting

U.S. deployment needs.

During fiscal 2000, sales, before pass through sales, increased

due to greater demand for the Company’s repair and overhaul

services, as well as the Company’s aircraft and engine sales and

leasing products. Sales in Aircraft and Engines during fiscal 2000

were negatively impacted by lower engine part sales reflecting

fewer shop visits at a main customer’s engine overhaul facilities.

Sales in Manufacturing during fiscal 2000 were lower mainly as

a result of the divestiture of the Company’s floor maintenance

products manufacturing facility which occurred in the second

quarter of fiscal 1999.

Pass through sales increased in fiscal 1999 compared to 1998

mainly as a result of new engine parts inventory management

programs, but declined in fiscal 2000 primarily as a result of the

aforementioned fewer shop visits at a certain customer’s engine

overhaul facilities.

The Company believes that its established global market posi-

tion, its ability to respond to changes in the industry, including

technological changes, and its diverse customer base, position

the Company to take advantage of future opportunities in the

aviation/aerospace market.*

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(in thousands, except percentage data)

*This section contains forward-looking statements which are identified with an asterisk (*). Please see comments on forward-looking statementrisk factors in the “Forward-Looking Statements” section on page 24.

Fiscal 2000 Compared with Fiscal 1999

Consolidated sales in fiscal 2000, before pass through sales,

increased 4.3% to $957,525 from $918,036 in fiscal 1999. This

increase was attributable to higher demand for the Company’s

aircraft and engine sales and leasing products, as well as strong

demand for the Company’s repair and overhaul services. Sales in

Aircraft and Engines increased $24,306 or 5.8%, as the Company

experienced strong demand for its whole engine and aircraft

products, partially offset by a continued decrease in sales from

engine parts inventory management programs. This decrease is

primarily the result of reduced demand by a major customer for

certain engine parts due principally to significantly fewer engine

shop visits to this customer for the engine types the Company

supports. The Company is working to resolve pending issues

with this customer, but no assurance can be given that sales to

this customer will continue at historical levels in the future.

The Company is aggressively pursuing inventory management

programs with other customers and building its engine parts

manufacturing capabilities to offset potential future reduced sales

to this customer.* Sales in Airframe and Accessories increased

$20,831 or 5.5%, reflecting increased demand for the Company’s

aircraft maintenance and landing gear and small component

overhaul and repair services. These increases were partially off-

set by lower new aircraft parts sales to general aviation

customers. Sales in Manufacturing declined $5,648 or 4.5%,

as a result of the divestiture of the Company’s floor mainte-

nance products manufacturing subsidiary in November 1998,

partially offset by higher sales of the Company’s products

supporting U.S. deployment needs. Pass through sales were

$66,808 compared to $132,572 in the prior year. As certain

of the Company’s inventory management programs have

matured, pass through sales have declined as the Company has

sourced more of its customers’ parts requirements with used,

serviceable parts, rather than with factory-new parts. The reduc-

tion in pass through sales during the current fiscal year is

attributable to the maturation of the Company’s existing long-

term inventory management programs, as well as a decline in

the number of shop visits for the engine types the Company

supports at certain long-term inventory management programs.

Consolidated gross profit was essentially even with the prior

fiscal year. The fiscal 2000 consolidated gross profit margin,

excluding the impact from pass through sales, was 18.1% in the

current fiscal year compared to 18.9% in the prior year. The

reduction in the consolidated gross profit margin was prima-

rily due to the unfavorable impact of the mix of inventories

sold. Selling, general and administrative expenses increased

$6,317 or 6.6%, as a result of a $4,000 fourth quarter charge

to increase bad debts reserve in response to the Company’s

accounts receivable exposure, which included two airlines that

filed for bankruptcy protection during fiscal 2000, as well as

increased information technology costs incurred as a result of

the Company’s e-business activities. Interest expense increased

$4,864 principally as a result of increased average short-term

borrowings outstanding during fiscal year 2000 as compared to

the prior year, and interest income increased $1,327 as a result

of an increase in average outstanding interest-bearing notes

receivable during the current year compared to the prior year.

Consolidated net income declined $6,508 or 15.6%, from the

prior year as a result of the above factors.

Fiscal 1999 Compared with Fiscal 1998

Consolidated sales in fiscal 1999, before pass through sales,

increased 17.4% to $918,036 from $782,123 in fiscal 1998.

This increase was attributable to continued strong demand for

the Company’s broad range of products and services and,

among other things, full-year sales from businesses acquired in

fiscal 1998. Aircraft and Engines sales increased $76,897 or

22.7%, resulting from higher sales of engine parts, driven pri-

marily from strength in inventory management programs, and

increased aircraft sales and leasing revenues. These increases were

partially offset by the impact of certain engine parts sales which

were recorded by Turbine Engine Asset Management L.L.C. (an

unconsolidated joint venture company) during fiscal 1999, but

were recorded by Aircraft and Engines during the first half of

fiscal 1998. Airframe and Accessories sales increased $42,976 or

12.9%, driven primarily by the impact of full-year sales from

the new-parts distribution companies acquired during fiscal

1998, as well as increased demand for aircraft maintenance

and landing gear overhaul repair capabilities. Manufacturing

sales increased $16,040 or 14.6%, due to increased sales of

products supporting the U.S. Government’s rapid deployment

program, the inclusion of full-year sales from AAR Composites

(acquired in fiscal 1998) and higher sales of cargo handling

systems. These gains were partially offset by the unfavorable

impact on sales as a result of the divestiture of the Company’s

floor maintenance products manufacturing subsidiary in

November 1998. Pass through sales were $132,572 compared

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to $74,514 in the prior year. The increase in pass through

sales in the current year as compared to the prior year was

attributable to the addition of new inventory management pro-

grams during fiscal 1999 and late fiscal 1998.

Consolidated gross profit increased $24,853 or 16.7%, due to

increased consolidated net sales. The fiscal 1999 consolidated

gross profit margin of 18.9%, excluding the impact from pass

through sales, is slightly less than the consolidated gross profit

margin of 19.0% of the prior year. Consolidated operating

income increased $12,665 or 19.6% over the prior year on the

strength of increased sales, partially offset by increased selling,

general and administrative expenses. Selling, general and admin-

istrative expenses were lower as a percentage of consolidated net

sales; however, total expenses increased due to the impact from

companies acquired during fiscal 1998, as well as increased

marketing support and information technology costs, which

include Year 2000 compliance costs. Interest expense increased

$4,073 or 28.1% over the prior year primarily due to the full-

year effect of the $60,000 of unsecured 6.875% Notes issued in

December 1997.

Consolidated net income increased $6,014 or 16.9% over the

prior year as a result of the above-noted factors.

Fiscal 1998 Compared with Fiscal 1997

Consolidated sales, before pass through sales, increased $192,795

or 32.7% over the prior fiscal year, reflecting strong demand

for the Company’s broad range of products and services and the

effect of acquisitions during fiscal 1998. Acquisitions, net of

prior year dispositions, contributed $77,234 to the sales

increase over the prior year. Aircraft and Engines sales increased

$76,225 or 29.0%, resulting from higher sales in its engine

and engine parts businesses, as well as increased aircraft sales.

Airframe and Accessories sales increased $111,850 or 50.5%,

driven primarily by sales from the new-parts distribution compa-

nies, which were acquired in fiscal 1998, and increased demand

for the Company’s aircraft maintenance and aircraft compo-

nent overhaul and repair capabilities. Sales in Manufacturing

increased $4,720 or 4.5%, reflecting increased cargo loading

and handling system sales and the inclusion of sales from ATR

(AAR Composites), which was acquired in October 1997, par-

tially offset by lower sales from products supporting the U.S.

Government’s rapid deployment program. Pass through sales

were $74,514 compared to $44,225 reflecting strong demand of

engine parts in the Company’s inventory management programs.

Consolidated gross profit increased $39,865 or 36.7%, due to

increased consolidated net sales and an increase in the consol-

idated gross profit margin to 19.0%, excluding the impact from

pass through sales, from 18.4% in the prior year. The increase

in the consolidated gross profit margin during fiscal 1998

reflected the favorable mix of inventories sold and improved

margins in certain manufactured products.

Consolidated operating income increased $21,826 or 50.9%

over the prior fiscal year as a result of the increase in net sales

and the higher gross profit margin, partially offset by increased

selling, general and administrative expenses. Selling, general

and administrative expenses were lower as a percentage of

consolidated net sales; however, total expenses increased princi-

pally due to the inclusion of recently acquired companies and

increased personnel costs. Interest expense increased $3,708 or

34.4% over the prior year, principally due to the impact of

the Company’s sale of $60,000 of unsecured 6.875% Notes

in December 1997.

Consolidated net income increased $12,632 or 54.9% over the

prior year as a result of the factors previously discussed.

Liquidity and Capital Resources

At May 31, 2000, the Company’s liquidity and capital resources

included cash and cash equivalents of $1,241 and working cap-

ital of $347,451. At May 31, 2000, the Company’s long-term

debt-to-capitalization ratio was 34.7% compared to 35.7%

at May 31, 1999, and the Company’s total debt-to-capitaliza-

tion ratio was 37.8% at May 31, 2000, compared to 35.7%

at May 31, 1999. The Company continues to maintain its

external sources of financing with $153,326 of unused avail-

able bank lines and a shelf registration statement on file with

the Securities and Exchange Commission under which up to

$200 million of common stock, preferred stock or medium-

or long-term debt securities may be issued or sold subject to

market conditions.

During fiscal 2000, the Company generated $10,051 of cash

flow from operations compared to $28,525 and $22,823 dur-

ing fiscal 1999 and 1998, respectively. The reduction in cash

flow generated from operations was principally due to a reduc-

tion in accounts and notes payable and accrued liabilities

during the current fiscal year.

During fiscal 2000, the Company’s investing activities used

$23,209, primarily reflecting the Company’s investment in

property, plant and equipment of $22,344.

23

During fiscal 2000, the Company’s financing activities gen-

erated $6,029 of cash, reflecting proceeds from short-term

borrowings of $25,885, partially offset by the purchase of the

Company’s stock of $10,530 and the payment of cash dividends

of $9,218.

The Company believes that its liquidity and available sources

of capital will continue to provide the Company with the ability

to meet its ongoing working capital requirements, make antici-

pated capital expenditures, meet contractual commitments and

pay dividends.*

A summary of key indicators of financial condition and lines

of credit follows:

May 31, 2000 1999

Working capital $347,451 $334,600

Current ratio 3.1:1 2.9:1

Bank credit lines:

Borrowings outstanding $ 25,885 $ —

Available but unused lines 153,326 178,800

Total credit lines $179,211 $178,800

Long-term debt, less current maturities $180,447 $180,939

Ratio of long-term debt to capitalization 34.7% 35.7%

Ratio of total debt to capitalization 37.8% 35.7%

Forward-Looking Statements

Management’s Discussion and Analysis of Financial Condition

and Results of Operations contains certain statements relating

to future results, which are forward-looking statements as that

term is defined in the Private Securities Litigation Reform Act

of 1995 and are identified by an asterisk(*). These forward-

looking statements are based on beliefs of Company manage-

ment, as well as assumptions and estimates based on informa-

tion currently available to the Company, and are subject to

certain risks and uncertainties that could cause actual results

to differ materially from historical results or those anticipated,

depending on a variety of factors, including: ability to acquire

inventory at favorable prices; integration of acquisitions; mar-

ketplace competition; economic and aviation/aerospace market

stability and Company profitability. Should one or more of these

risks or uncertainties materialize adversely, or should underlying

assumptions or estimates prove incorrect, actual results may

vary materially from those described.

Quantitative and Qualitative Disclosures

about Market Risk

The Company’s exposure to market risk is limited to fluctuat-

ing interest rates under its unsecured bank credit agreements

and foreign exchange rates. During fiscal 2000 and 1999, the

Company did not utilize derivative financial instruments to off-

set these risks.

At May 31, 2000, $65,300 was available under credit lines

with domestic banks, $84,115 was available under revolving

credit and term loan agreements with domestic banks, and

$3,911 was available under credit agreements with foreign banks

(credit facilities). Interest on amounts borrowed under the credit

facilities is based on an overnight bid rate. As of May 31, 2000,

the outstanding balance under these agreements was $25,885.

A hypothetical 10 percent increase to the average interest rate

under the credit facilities would not have had a material impact

on the results of operations for the Company during fiscal 2000.

Revenues and expenses of the Company’s foreign operations

in The Netherlands are translated at average exchange rates

during the year and balance sheet accounts are translated at

year-end exchange rates. Balance sheet translation adjustments

are excluded from the results of operations and are recorded

in stockholders’ equity as a component of accumulated other

comprehensive income (loss). A hypothetical 10 percent devalu-

ation of foreign currencies against the U.S. dollar would not

have a material impact on the financial position or results of

operations of the Company.

24

25

Financial Statistics

(000’s omitted, except per share data, ratios and employees)

for the year ended May 31, 2000 1999 1998 1997 1996

Operating Performance

Sales $ 957,525 $ 918,036 $782,123 $589,328 $504,990

Pass through sales (a) 66,808 132,572 74,514 44,225 44,977

Total sales 1,024,333 1,050,608 856,637 633,553 549,967

Gross profit 172,853 173,259 148,406 108,541 90,765

Operating income 70,658 77,381 64,716 42,890 32,442

Interest expense 23,431 18,567 14,494 10,786 10,616

Income before provision for income taxes 49,526 59,786 51,157 32,975 22,782

Net income 35,163 41,671 35,657 23,025 16,012

Financial Position

Working capital $ 347,451 $ 334,600 $319,252 (d) $314,119 (e) $258,627

Total assets 740,998 726,630 670,559 529,584 (e) 437,846

Short-term debt 26,314 420 237 (d) 1,474 1,474

Long-term debt 180,447 180,939 177,509 (d) 116,818 118,292

Total debt 206,761 181,359 177,746 (d) 118,292 119,766

Stockholders’ equity 339,515 326,035 300,850 269,259 (e) 204,635

Number of shares outstanding at

end of year (b) 26,865 27,381 27,717 27,306 (e) 23,997

Book value per share of common stock (b) $ 12.64 $ 11.91 $ 10.85 $ 9.86 $ 8.53

Ratio Analysis

Current ratio 3.1:1 2.9:1 3.1:1 4.1:1 4.3:1

Return on sales (c) 3.7% 4.5% 4.6% 3.9% 3.2%

Gross profit margin (c) 18.1% 18.9% 19.0% 18.4% 18.0%

Return on average invested capital 9.3% 10.9% 10.4% 8.5% 7.1%

Return on average equity 10.5% 13.3% 12.5% 10.2% 8.2%

Ratio of long-term debt to capitalization 34.7% 35.7% 37.1% (d) 30.3% 36.6%

Ratio of total debt to capitalization 37.8% 35.7% 37.2% (d) 30.5% 37.1%

Sales per employee (c) $ 331 $ 323 $ 318 $ 271 $ 244

Share Data (b)

Earnings per share—basic $ 1.30 $ 1.51 $ 1.29 $ .92 $ .67

Earnings per share—diluted $ 1.28 $ 1.49 $ 1.27 $ .91 $ .66

Cash dividends per share $ .34 $ .34 $ .33 $ .32 $ .32

Average common shares outstanding—basic 27,103 27,549 27,588 25,026 (e) 23,967

Average common shares outstanding—diluted 27,415 28,006 28,174 25,399 (e) 24,248

Number of Employees 2,900 2,900 2,700 2,100 2,140

(a) In connection with certain long-term inventory management programs, the Company purchases factory-new products on behalf of its customers from

original equipment manufacturers. These products are purchased from the manufacturer and “passed through” to the Company’s customers at the

Company’s cost. Beginning with the third quarter of fiscal 2000, the Company began reporting “pass through” sales on the Income Statement.

(b) All share and per share information reflects the three-for-two stock split on February 23, 1998.

(c) Ratios are calculated on sales before pass through sales.

(d) In December 1997, the Company sold $60,000 of unsecured 6.875% Notes due December 15, 2007.

(e) In February 1997, the Company sold three million shares of its common stock for $50,075, net of expenses.

26

Quarterly Results of Operations

(000’s omitted, except per share data)

Market Prices and Dividends

Fiscal 2000

Diluted EarningsQuarter Sales Gross Profit Net Income Per Share

First $ 266,683 $ 44,190 $10,831 $ .39

Second 260,240 45,728 10,906 .40

Third 272,331 45,074 10,955 .40

Fourth 225,079 37,861 2,471 .09

$1,024,333 $172,853 $35,163 $1.28

Fiscal 1999

Diluted EarningsQuarter Sales Gross Profit Net Income Per Share

First $ 250,491 $ 41,049 $ 9,623 $ .34

Second 282,232 42,740 10,035 .36

Third 250,984 42,706 10,278 .37

Fourth 266,901 46,764 11,735 .42

$1,050,608 $173,259 $41,671 $1.49

Per Common Share Fiscal 2000 Fiscal 1999

Market Prices Quarterly Market Prices QuarterlyQuarter High Low Dividends High Low Dividends

First 23 1⁄4 18 3⁄8 $.085 29 15⁄16 22 1⁄8 $.085

Second 21 15⁄16 15 15⁄16 .085 25 3⁄8 17 3⁄4 .085

Third 26 7⁄8 15 13⁄16 .085 25 3⁄8 15 .085

Fourth 23 5⁄8 13 7⁄8 .085 21 9⁄16 15 3⁄8 .085

$.340 $.340

27

Consolidated Statements of Income

(000s omitted except per share data)

for the year ended May 31, 2000 1999 1998

Sales $ 957,525 $ 918,036 $782,123

Pass through sales 66,808 132,572 74,514

1,024,333 1,050,608 856,637

Costs and operating expenses:

Cost of sales 851,480 877,349 708,231

Selling, general and administrative 102,195 95,878 83,690

953,675 973,227 791,921

Operating income 70,658 77,381 64,716

Interest expense (23,431) (18,567) (14,494)

Interest income 2,299 972 935

Income before provision for income taxes 49,526 59,786 51,157

Provision for income taxes 14,363 18,115 15,500

Net income $ 35,163 $ 41,671 $ 35,657

Earnings per share of common stock—basic $ 1.30 $ 1.51 $ 1.29

Earnings per share of common stock—diluted $ 1.28 $ 1.49 $ 1.27

The accompanying notes to consolidated financial statements are an integral part of these statements.

28

Consolidated Balance Sheets

(000s omitted)

Assets May 31, 2000 May 31, 1999

Current assets:

Cash and cash equivalents $ 1,241 $ 8,250

Accounts receivable 128,348 164,302

Inventories 275,817 270,654

Equipment on or available for short-term leases 60,201 33,845

Deferred tax assets, deposits and other 45,660 31,135

Total current assets 511,267 508,186

Property, plant and equipment, at cost:

Land 6,331 6,331

Buildings and improvements 68,387 66,123

Equipment, furniture and fixtures 127,879 111,718

202,597 184,172

Accumulated depreciation (92,594) (80,160)

110,003 104,012

Other assets:

Investment in leveraged leases 34,487 34,053

Cost in excess of underlying net assets of acquired companies, net 38,840 40,093

Other 46,401 40,286

119,728 114,432

$740,998 $726,630

Liabilities and Stockholders’ Equity

Current liabilities:

Short-term debt $ 25,885 $ —

Current maturities of long-term debt 429 420

Accounts and trade notes payable 107,879 129,703

Accrued liabilities 26,596 36,803

Accrued taxes on income 3,027 6,660

Total current liabilities 163,816 173,586

Long-term debt, less current maturities 180,447 180,939

Deferred tax liabilities 56,020 44,870

Retirement benefit obligation 1,200 1,200

237,667 227,009

Stockholders’ equity:

Preferred stock, $1.00 par value, authorized 250 shares; none issued — —

Common stock, $1.00 par value, authorized 100,000 shares;

issued 29,168 and 28,998, respectively 29,168 28,998

Capital surplus 146,557 144,095

Retained earnings 210,474 184,529

Treasury stock, 2,303 and 1,617 shares at cost, respectively (37,236) (25,463)

Accumulated other comprehensive income (loss)—

cumulative translation adjustments (9,448) (6,124)

339,515 326,035

$740,998 $726,630

The accompanying notes to consolidated financial statements are an integral part of these statements.

29

Consolidated Statements of Stockholders’ Equity

(000s omitted)

AccumulatedOther

Common Stock Treasury Stock Capital Retained Comprehensive Comprehensivefor the three years ended May 31, 2000 Shares Amount Shares Amount Surplus Earnings Income (Loss) Income (Loss)

Balance, May 31, 1997 18,932 $18,932 728 $(13,365) $141,016 $125,694 $(3,018)

Net income — — — — — 35,657 — $35,657

Cash dividends — — — — — (9,118) —

Issuance of common stock — — (93) 1,699 1,158 — —

Treasury stock — — 126 (4,804) — — —

Three-for-two stock split 9,589 9,589 367 — (9,589) — —

Exercise of stock options and

stock awards 311 311 — — 8,313 — —

Adjustment for net translation loss — — — — — — (1,625) (1,625)

Comprehensive income for fiscal 1998 $34,032

Balance, May 31, 1998 28,832 $28,832 1,128 $(16,470) $140,898 $152,233 $(4,643)

Net income — — — — — 41,671 — $41,671

Cash dividends — — — — — (9,375) —

Treasury stock — — 489 (8,993) — — —

Exercise of stock options and

stock awards 166 166 — — 3,197 — —

Adjustment for net translation loss — — — — — — (1,481) (1,481)

Comprehensive income for fiscal 1999 $40,190

Balance, May 31, 1999 28,998 $28,998 1,617 $(25,463) $144,095 $184,529 $(6,124)

Net income — — — — — 35,163 — $35,163

Cash dividends — — — — — (9,218) —

Treasury stock — — 686 (11,773) — — —

Exercise of stock options and

stock awards 170 170 — — 2,462 — —

Adjustment for net translation loss — — — — — — (3,324) (3,324)

Comprehensive income for fiscal 2000 $31,839

Balance, May 31, 2000 29,168 $29,168 2,303 $(37,236) $146,557 $210,474 $(9,448)

The accompanying notes to consolidated financial statements are an integral part of these statements.

30

Consolidated Statements of Cash Flows

(000s omitted)

for the year ended May 31, 2000 1999 1998

Cash flows from operating activities:

Net income $ 35,163 $ 41,671 $ 35,657

Adjustments to reconcile net income to net cash provided

from operating activities:

Depreciation and amortization 18,373 17,063 14,283

Deferred taxes 9,570 10,970 3,780

Change in certain assets and liabilities:

Accounts receivable 31,532 (6,991) (14,922)

Inventories (6,644) (46,212) (34,706)

Equipment on or available for short-term leases (26,593) 3,214 6,664

Accounts and trade notes payable (21,536) 24,659 2,730

Accrued liabilities and taxes on income (13,786) (3,933) 16,936

Other (16,028) (11,916) (7,599)

Net cash provided from operating activities 10,051 28,525 22,823

Cash flows from investing activities:

Property, plant and equipment expenditures, net (22,344) (36,131) (17,495)

Acquisitions, less cash acquired — (15,175) (28,148)

Proceeds from sale of business — 11,685 —

Investment in equipment on long-term leases and leveraged leases (434) 23,369 (33,538)

Notes receivable and other (431) (6,641) (19,948)

Net cash used in investing activities (23,209) (22,893) (99,129)

Cash flows from financing activities:

Proceeds from issuance of long-term notes payable — — 59,347

Proceeds from short-term debt 25,885 — —

Change in borrowings (484) 2,053 (10,170)

Cash dividends (9,218) (9,375) (9,118)

Purchases of treasury stock (10,530) (7,558) —

Proceeds from exercise of stock options and other 376 278 1,642

Net cash provided from (used in) financing activities 6,029 (14,602) 41,701

Effect of exchange rate changes on cash 120 (2) 122

(Decrease) in cash and cash equivalents (7,009) (8,972) (34,483)

Cash and cash equivalents, beginning of year 8,250 17,222 51,705

Cash and cash equivalents, end of year $ 1,241 $ 8,250 $ 17,222

The accompanying notes to consolidated financial statements are an integral part of these statements.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

AAR CORP. (the Company) supplies a variety of products and

services to the worldwide aviation/aerospace industry. Products

and services are sold primarily to commercial, domestic and

foreign airlines; business aircraft operators; aviation original

equipment manufacturers; aircraft leasing companies; domestic

and foreign military agencies and independent aviation sup-

port companies.

Principles of Consolidation

The accompanying consolidated financial statements include

the accounts of the Company and its subsidiaries after elimina-

tion of intercompany accounts and transactions.

The Company conducts portions of its business through joint

venture investments accounted for under the equity method.

These equity affiliates are primarily engaged in the distribution

of certain engine parts and aircraft rotable spares to worldwide

aviation customers. The financial position and results of opera-

tions for the joint ventures during fiscal 2000 and 1999 are

not material.

Revenue Recognition

Sales and related cost of sales are recognized primarily upon

shipment of products and performance of services. Lease revenue

is recognized as earned.

In connection with certain long-term inventory management

programs, the Company purchases factory-new products on

behalf of its customers from original equipment manufacturers.

These products are purchased from the manufacturer and

“passed through” to the Company’s customer at the Company’s

cost. Previously, the Company disclosed these “pass through”

sales in the notes to the consolidated financial statements and

excluded these transactions from sales and cost of sales.

During the third quarter of fiscal 2000, the SEC issued Staff

Accounting Bulletin (SAB) No. 101 summarizing the SEC’s

view in applying generally accepted accounting principles to rev-

enue recognition. As a result of SAB No. 101, the Company

now believes that pass through sales should be included in sales.

Prior to issuance of SAB No. 101, the Company believed that

excluding pass through sales from sales was appropriate given

the limited nature of the services provided for these transactions.

Beginning with the third quarter Form 10-Q, the Company

reported pass through sales and the related cost of sales on the

Consolidated Income Statement. This change has no impact on

the current period or historical net income, earnings per share,

condensed consolidated balance sheets, statements of cash flows

or comprehensive income.

Segment Information

SFAS No. 131 “Disclosures about Segments of an Enterprise and

Related Information” establishes standards for public companies

to report financial and descriptive information about reportable

operating segments in annual financial statements and interim

financial reports issued to stockholders. The Company operates

in one segment: Aviation Services. The Company’s determination

of its reportable segment is based on the commonalities among

the products and services within its Aviation Services segment,

and is consistent with the manner in which the Company’s

management reviews and evaluates operating performance.

New Accounting Standards

SFAS No. 133 “Accounting for Derivative Instruments and

Hedging Activities” is effective for fiscal years beginning after

June 15, 2000. SFAS No. 133 establishes accounting and report-

ing standards for derivative instruments and for certain

hedging activities. It requires that an entity recognize all deriva-

tives as either assets or liabilities in the statement of financial

position and measure those instruments at fair value. The

Company is evaluating the new Statement’s provisions to deter-

mine the impact, if any, and will adopt SFAS No. 133 in its

first quarter of fiscal 2002.

Cash and Cash Equivalents

The Company considers all highly liquid investments with

maturities of three months or less to be cash equivalents. At

May 31, 2000 and 1999, cash equivalents of approximately

$122 and $116, respectively, represent investments in funds

holding high-quality commercial paper, Eurodollars and U.S.

Government agency-issued securities. The carrying amount of

cash equivalents approximates fair value at May 31, 2000 and

1999, respectively.

31

Notes to Consolidated Financial Statements

(in thousands, except per share and percentage data)

Transfer of Financial Assets

During fiscal 1998, the Company adopted SFAS No. 125,

“Accounting for Transfers and Servicing of Financial Assets and

Extinguishments of Liabilities,” which requires the Company

to recognize the financial and servicing assets it controls and the

liabilities it has incurred, and to derecognize financial assets when

control has been surrendered.

The Company has an agreement to sell, on a revolving basis,

an interest in a defined pool of trade accounts receivable up

to $35,000. The Company, as agent for the purchaser of the

accounts receivable, retains collection and administrative respon-

sibilities for the participating interests of accounts receivable.

Accounts receivable sold under this arrangement were $29,359

and $25,300 at May 31, 2000 and 1999, respectively.

Foreign Currency

Gains and losses on foreign currency translation and foreign

exchange contracts are determined in accordance with the

method of accounting prescribed by SFAS No. 52. All balance

sheet accounts of foreign and certain domestic subsidiaries

transacting business in currencies other than the Company’s

functional currency are translated at year-end or historical

exchange rates. Revenues and expenses are translated at average

exchange rates during the year. Translation adjustments are

excluded from the results of operations and are recorded in

stockholders’ equity as a component of accumulated other com-

prehensive income (loss).

Financial Instruments and Concentrations

of Market or Credit Risk

Financial instruments that potentially subject the Company to

concentrations of market or credit risk consist principally of

trade receivables. While the Company’s trade receivables are

diverse based on the number of entities and geographic

regions, the majority are in the aviation/aerospace industry.

The Company performs evaluations of customers’ financial

condition prior to extending credit privileges and performs

ongoing credit evaluations of payment experience, current

financial condition and risk analysis. The Company typically

requires collateral in the form of security interest in assets,

letters of credit, and/or obligation guarantees from financial

institutions, or sells its receivables, usually on a nonrecourse

basis, for transactions other than normal trade terms.

SFAS No. 107 “Disclosures about Fair Value of Financial

Instruments” requires disclosure of the fair value of certain

financial instruments. Cash and cash equivalents, accounts receiv-

able, short-term borrowings, accounts payable and accrued

liabilities are reflected in the consolidated financial statements

at fair value because of the short-term maturity of these instru-

ments. The carrying value of noncurrent notes receivable and

long-term debt bearing a variable interest rate approximates fair

market value.

Fair value estimates are made at a specific point in time based

on relevant market information about the financial instrument.

These estimates are subjective in nature and involve uncertain-

ties and matters of significant judgment and therefore cannot

be determined with precision. Changes in assumptions could

significantly affect the estimates.

Inventories

Inventories are priced at the lower of cost or market. Cost is

determined by either the specific identification, average cost or

first-in, first-out method.

The following is a summary of inventories:

May 31, 2000 1999

Raw materials and parts $ 44,235 $ 50,352

Work-in-process 12,318 12,733

Purchased aircraft, parts, engines

and components held for sale 219,264 207,569

$275,817 $270,654

Equipment under Operating Leases

Lease revenue is recognized as earned. The cost of the asset

under lease is original purchase price plus overhaul costs.

Depreciation is computed on a straight-line method over the

estimated service life of the equipment, and maintenance costs

are expensed as incurred. The balance sheet classification is

based on the lease term, with fixed-term leases less than twelve

months classified as short-term and all others classified as

long-term.

Equipment on short-term lease consists of aircraft engines and

parts on or available for lease to satisfy customers’ immediate

short-term requirements. The leases are renewable with fixed

terms, which generally vary from one to twelve months.

32

Property, Plant and Equipment

Depreciation is computed on the straight-line method over

useful lives of 10–40 years for buildings and improvements

and 3–10 years for equipment, furniture and fixtures, and cap-

italized software. Leasehold improvements are amortized over

the shorter of the estimated useful life or the term of the

applicable lease.

Repairs and maintenance expenditures are expensed as incurred.

Upon sale or disposal, cost and accumulated depreciation are

removed from the accounts, and related gains and losses are

included in results of operations.

Leveraged Leases

The Company acts as an equity participant in leveraged lease

transactions. The equipment cost in excess of equity contri-

bution is financed by third parties in the form of secured debt.

Under the lease agreements, the third parties have no recourse

against the Company for nonpayment of the obligations. The

third-party debt is collateralized by the lessees’ rental obliga-

tions and the leased equipment.

The Company has ownership rights to the leased assets and is

entitled to the investment tax credits and benefits of tax

deductions for depreciation on the leased assets and for interest

on the secured debt financing.

Cost in Excess of Underlying Net Assets

of Acquired Companies

The cost in excess of underlying net assets of acquired

companies is being amortized over a period of 40 years.

Amortization expense was $1,213, $802 and $565 in fiscal

2000, 1999 and 1998, respectively. Accumulated amortization

is $6,188 and $4,975 at May 31, 2000 and 1999, respectively.

The Company evaluates the existence of impairment on the

basis of whether the cost in excess of underlying net assets of

acquired companies is fully recoverable from projected, undis-

counted net cash flows.

Income Taxes

Income taxes are determined in accordance with SFAS No. 109.

The benefits of investment tax credits are recognized for finan-

cial reporting purposes under the deferral method of accounting

for leveraged leases. The investment tax credits are recognized

in the year earned for income tax purposes.

Statements of Cash Flows

Supplemental information on cash flows follows:

for the year ended May 31, 2000 1999 1998

Interest paid $22,800 $18,800 $11,600

Income taxes paid 11,300 4,400 6,200

Income tax refunds

and interest received 500 900 6,000

Use of Estimates

Management of the Company has made estimates and

assumptions relating to the reporting of assets and liabilities

and the disclosure of contingent liabilities to prepare these

consolidated financial statements in conformity with generally

accepted accounting principles. Actual results could differ from

those estimates.

Reclassification

Certain amounts in the prior years’ consolidated financial

statements have been reclassified to conform to the current

year’s presentation.

33

2. FINANCING ARRANGEMENTS

Term loans consisted of:

May 31, 2000 1999 1998

Current maturities of

long-term debt $429 $420 $237

Short-term borrowing activity was as follows:

for the year ended May 31, 2000 1999 1998

Maximum amount borrowed $127,600 $92,300 $59,200

Average daily borrowings 94,881 45,455 20,689

Average interest rate

during the year 5.9% 5.4% 6.0%

At May 31, 2000, aggregate unsecured bank credit arrange-

ments were $179,211. Of this amount, $65,300 was available

under credit lines with domestic banks, $84,115 was available

under revolving credit and term loan agreements with domes-

tic banks, and $3,911 was available under credit agreements with

foreign banks. There are no compensating balance requirements

in connection with domestic or foreign lines of credit. Borrowings

under domestic bank lines bear interest at or below the corpo-

rate base rate.

The Company may borrow a maximum of $110,000 (avail-

able through February 9, 2002) under revolving credit and

term loan agreements with domestic banks. Revolving credit

borrowings may, at the Company’s option, be converted to

term loans payable in equal quarterly installments over five

years. Interest is based on the corporate base rate or quoted

Eurodollar or multicurrency rates during the revolving credit

period and one-half percent over the corporate base rate or

quoted Eurodollar rate thereafter. Borrowings outstanding

under these agreements at May 31, 2000 were $25,885. There

are no compensating balance requirements on any of the

committed lines, but the Company is required to pay a com-

mitment fee. There are no restrictions on the withdrawal or

use of these funds.

Long-term debt was as follows:

May 31, 2000 1999

Notes payable due November 1, 2001

with interest of 9.5% payable semi-

annually on May 1 and November 1 $ 65,000 $ 65,000

Notes payable due October 15, 2003

with interest of 7.25% payable semi-

annually on April 15 and October 15 50,000 50,000

Notes payable due December 15, 2007

with interest of 6.875% payable semi-

annually on June 15 and December 15 60,000 60,000

Industrial revenue bonds due in quarterly

installments to 2011 with weighted

average interest of approximately

4.60% at May 31, 2000 (secured

by trust indentures on property,

plant and equipment) 2,158 2,358

Industrial revenue bonds due in

installments to 2002 with weighted

average interest of approximately

7.47% at May 31, 2000 (secured by

trust indentures on property, plant

and equipment) 84 141

Industrial revenue bonds due in monthly

installments to 2019 with interest of

5.65% (secured by trust indentures

on property, plant and equipment) 2,171 2,235

Note payable due in annual installments

to October 2003 with interest of 6.5% 1,463 1,625

180,876 181,359

Current maturities (429) (420)

$180,447 $180,939

The Company is subject to a number of covenants under the

revolving credit and term loan agreements, including restric-

tions which relate to the payment of cash dividends,

maintenance of minimum net working capital and tangible net

worth levels, sales of assets, additional financing, purchase of

the Company’s shares and other matters. The Company is in

compliance with all restrictive financial provisions of the agree-

ments. At May 31, 2000, unrestricted consolidated retained

earnings available for payment of dividends and purchase of

the Company’s shares was approximately $19,504. Effective

June 1, 2000, unrestricted consolidated retained earnings

increased to $37,086 due to inclusion of 50% of the consoli-

dated net income of the Company for fiscal 2000. The

aggregate amount of long-term debt maturing during each

of the next five fiscal years is $429 in 2001, $65,411 in 2002,

$394 in 2003, $51,407 in 2004 and $284 in 2005. The

34

Company’s long-term debt was estimated to have a fair value

of approximately $172,426 at May 31, 2000 and was based on

estimates using discounted future cash flows at an assumed rate

for borrowings currently prevailing in the marketplace for sim-

ilar instruments.

3. INCOME TAXES

The provision for income taxes included the following

components:

for the year ended May 31, 2000 1999 1998

Current

Federal $ 4,070 $ 6,045 $ 9,950

Foreign — — 720

State 723 1,100 1,050

$ 4,793 $ 7,145 $11,720

Deferred 9,570 10,970 3,780

$14,363 $18,115 $15,500

The deferred tax provisions result primarily from differences

between financial reporting and tax income arising from depre-

ciation and leveraged leases.

Deferred tax liabilities and assets result primarily from the dif-

ferences in the timing of the recognition for transactions

between financial reporting and income tax purposes and con-

sist of the following components:

May 31, 2000 1999

Deferred tax liabilities:

Depreciation $28,710 $16,920

Leveraged leases 27,120 27,440

Other 630 620

Total deferred tax liabilities $56,460 $44,980

Deferred tax assets—current:

Inventory costs $ 3,160 $ 3,090

Employee benefits 2,980 2,410

Alternative minimum tax 1,090 —

Other 240 390

Total deferred tax assets—current $ 7,470 $ 5,890

Deferred tax assets—noncurrent:

Postretirement benefits $ 440 $ 110

Total deferred tax assets—noncurrent 440 110

Total deferred tax assets $ 7,910 $ 6,000

Net deferred tax liabilities $48,550 $38,980

The Company has determined that the realization of deferred

tax assets is more likely than not, and that a valuation allowance

is not required based upon the Company’s history of prior oper-

ating earnings, its expectations for continued future earnings

and the scheduled reversal of deferred tax liabilities, primarily

related to leveraged leases, which exceed the amount of the

deferred tax assets.

The provision for income taxes differs from the amount computed

by applying the U.S. Federal statutory income tax rate of 35%

for fiscal 2000, 1999 and 1998, for the following reasons:

for the year ended May 31, 2000 1999 1998

Provision for income taxes at

the Federal statutory rate $17,330 $20,925 $17,905

Tax benefits on exempt

earnings from export sales (3,815) (3,690) (3,100)

State income taxes, net of

Federal benefit and refunds 900 900 900

Amortization of goodwill 298 280 200

Differences between foreign

tax rates and the U.S.

Federal statutory rate — — (200)

Other, net (350) (300) (205)

Provision for income taxes

as reported $14,363 $18,115 $15,500

Effective income tax rate 29.0% 30.3% 30.3%

35

4. COMMON STOCK AND STOCK OPTION PLANS

The Company has established stock option plans for officers

and key employees of the Company. Stock option awards typi-

cally expire ten years from the date of grant or earlier upon

termination of employment, become exercisable in five equal

increments on successive grant anniversary dates at the New

York Stock Exchange closing stock price on the date of grant

and are accompanied by reload features and, for certain indi-

viduals, stock rights exercisable in the event of a change in

control of the Company.

The Company accounts for these plans under APB No. 25,

under which no compensation cost has been recognized. Proforma

information regarding net income and earnings per share is

required by SFAS No. 123 and has been determined as if the

Company had accounted for its employee stock options under

the fair value method of SFAS No. 123. The fair value of each

option grant, including reloads, is estimated on the date of

grant using the Black-Scholes option-pricing model with the

following weighted average assumptions:

Stock Options Granted in Fiscal Year 2000 1999 1998

Risk-free interest rate 6.57% 5.74% 5.97%

Expected volatility of

common stock 38.7% 31.6% 25.5%

Dividend yield 1.6% 1.8% 2.0%

Expected option term

in years 4.0 4.0 4.0

The fair value weighted average per share of stock options

granted during fiscal 2000, 1999 and 1998 was $7.81, $5.20

and $5.04, respectively. Had compensation cost for stock

options awarded under the plans been determined in accor-

dance with SFAS No. 123, the Company’s net income and

earnings per share would have been changed to the following

proforma amounts:

May 31, 2000 1999 1998

Net income:

As reported $35,163 $41,671 $35,657

Proforma 33,097 40,403 34,478

Earnings per share—basic:

As reported 1.30 1.51 1.29

Proforma 1.22 1.47 1.25

Earnings per share—diluted:

As reported 1.28 1.49 1.27

Proforma 1.21 1.44 1.22

A summary of changes in stock options granted to officers,

key employees and non-employee directors under stock option

plans for the three years ended May 31, 2000 follows:

Number of Weighted AverageShares Exercise Price

Outstanding, May 31, 1997

(664 exercisable) 1,978 $12.48

Granted 891 23.57

Exercised (339) 11.32

Surrendered/expired/cancelled (46) 16.17

Outstanding, May 31, 1998

(785 exercisable) 2,484 $16.54

Granted 827 19.41

Exercised (71) 11.95

Surrendered/expired/cancelled (64) 18.53

Outstanding, May 31, 1999

(1,148 exercisable) 3,176 $17.36

Granted 519 22.48

Exercised (105) 12.40

Surrendered/expired/cancelled (164) 20.05

Outstanding, May 31, 2000

(1,508 exercisable) 3,426 $18.16

36

The AAR CORP. Stock Benefit Plan also provides for the

grant of restricted stock awards. Restrictions are released at the

end of applicable restricted periods. The number of shares and

the restricted period, which varies from two to ten years, are

determined by the Compensation Committee of the Board of

Directors. The market value of the award on the date of grant

is recorded as a deferred expense, Common stock and Capital

surplus. The deferred expense is included in results of operations

over the vesting period. The expense relating to outstanding

restricted stock awards was $1,354, $1,667 and $1,400 in fiscal

2000, 1999 and 1998, respectively.

The AAR CORP. Employee Stock Purchase Plan is open to

employees of the Company (other than officers, directors or

participants in other stock option plans of the Company) and

permits employees to purchase common stock in periodic

offerings by payroll deductions.

The numbers of options and awards outstanding and available

for grant or issuance for each of the Company’s stock plans

are as follows:

May 31, 2000 Outstanding Available Total

Stock Benefit Plan

(officers, directors and

key employees) 3,751 1,314 5,065

Employee Stock

Purchase Plan 29 133 162

Pursuant to a shareholder rights plan adopted in 1997, each

outstanding share of the Company’s common stock carries with

it a Right to purchase one and one half additional shares at a

price of $83.33 per share (adjusted to reflect the February 23,

1998 stock split and subject to further antidilution adjust-

ments). The Rights become exercisable (and separate from the

shares) when certain specified events occur, including the

acquisition of 15% or more of the common stock by a per-

son or group (an “Acquiring Person”) or the commencement of a

tender or exchange offer for 15% or more of the common stock.

In the event that an Acquiring Person acquires 15% or more

of the common stock, or if the Company is the surviving cor-

poration in a merger involving an Acquiring Person or if the

Acquiring Person engages in certain types of self-dealing trans-

actions, each Right entitles the holder to purchase, for $83.33

per share (or the then-current exercise price), shares of the

Company’s common stock having a market value of $166.66

(or two times the exercise price), subject to certain exceptions.

Similarly, if the Company is acquired in a merger or other busi-

ness combination or 50% or more of its assets or earning

power is sold, each Right entitles the holder to purchase at the

then-current exercise price that number of shares of common

stock of the surviving corporation having a market value of

two times the exercise price. The Rights, which do not entitle

the holder thereof to vote or to receive dividends, replace the

common stock purchase rights which were initially distributed

to the Company’s shareholders in 1987 and which expired by

their own terms on August 6, 1997. The Rights will expire on

August 6, 2007, and may be redeemed by the Company for

$.01 per Right under certain circumstances.

On September 21, 1990, the Board of Directors authorized

the Company to purchase up to 1,500 shares (adjusted for the

three-for-two stock split) of the Company’s common stock on

the open market or through privately negotiated transactions.

On October 13, 1999, the Board of Directors authorized the

Company to purchase up to 1,500 additional shares of the

Company’s common stock. As of May 31, 2000, the Company

had purchased 1,701 shares of its common stock on the open

market under these programs at an average price of $14.12

per share.

37

The following table provides additional information regarding options outstanding as of May 31, 2000:

Weighted Average Number of Weighted AverageOption Exercise Options Remaining Contractual Options Exercise Price of

Price Range Outstanding Life of Options (Years) Exercisable Options Exercisable

$ 6.13–12.25 649 4.1 582 $ 9.74

$12.26–18.38 1,253 6.7 619 15.65

$18.39–24.50 1,435 7.9 226 22.61

$24.51–30.63 89 4.6 81 27.09

3,426 6.6 1,508 $14.98

5. EARNINGS PER SHARE

The computation of basic earnings per share is based on

the weighted average number of common shares outstanding

during the year. Diluted earnings per share is based on the

weighted average number of common shares outstanding during

the year plus, when their effect is dilutive, common stock equiva-

lents consisting of shares subject to stock options. The following

table provides a reconciliation of the computations of basic and

diluted earnings per share information for each of the years in

the three-year period ended May 31, 2000.

May 31, 2000 1999 1998

Basic EPS:

Net income $35,163 $41,671 $35,657

Average common shares

outstanding 27,103 27,549 27,588

Earnings per share—basic $ 1.30 $ 1.51 $ 1.29

Diluted EPS:

Net income $35,163 $41,671 $35,657

Average common shares

outstanding 27,103 27,549 27,588

Additional shares due

to hypothetical exercise

of stock options 312 457 586

Earnings per share—diluted $ 1.28 $ 1.49 $ 1.27

In January 1998, the Board of Directors declared a three-for-two

stock split, which was effected in the form of a stock dividend

on February 23, 1998, to shareholders of record February 2, 1998,

and a quarterly cash dividend of 8.5 cents per share on the

increased shares, which effectively increased the cash dividend

payment by 6.25%.

6. EMPLOYEE BENEFIT PLANS

The Company has defined contribution or defined benefit

plans covering substantially all full-time domestic employees

and certain employees in The Netherlands.

Defined Benefit Plans

Prior to January 1, 2000, the pension plan for domestic salaried

employees had benefit formulas primarily based on years of

service and compensation. Effective January 1, 2000, the

Company converted its existing defined benefit plan for sub-

stantially all domestic salaried employees to a cash balance

pension plan. Under the cash balance pension plan, the retire-

ment benefit is expressed as a dollar amount in an account that

grows with annual pay-based credits and interest on the account

balance. The pension benefit for hourly employees is generally

based on a fixed amount per year of service. The Company fol-

lows the provisions of SFAS No. 87 “Employers’ Accounting for

Pensions” and SFAS No. 132 “Employers’ Disclosures about

Pension and Other Postretirement Benefits” for all pension and

postretirement plans.

The Company’s funding policy for domestic plans is to

contribute annually, at a minimum, an amount which is

deductible for Federal income tax purposes and that is suf-

ficient to meet actuarially computed pension benefits.

Contributions are intended to provide for benefits attributed

to service to date and for benefits expected to be earned in

the future. The assets of the pension plans are invested pri-

marily in mutual funds, common stocks, investment grade

bonds and U.S. Government obligations.

Certain foreign operations of domestic subsidiaries also have

pension plans. In most cases, the plans are defined benefit in

nature. Assets of the plans are comprised of insurance contracts.

Benefit formulas are based generally on years of service and com-

pensation. It is the policy of these subsidiaries to fund at least

the minimum amounts required by local law and regulation.

38

The following table sets forth the plans’ funded status, including

the change in plan assets, and the amount recognized in the

Company’s Consolidated Balance Sheets.

May 31, 2000 1999

Change in benefit obligation:

Benefit obligation at beginning of year $50,154 $46,384

Service cost 2,647 2,315

Interest cost 3,791 3,334

Plan participants’ contributions 220 171

Amendments 1,231 —

Net actuarial (gain) loss (2,556) (25)

Benefits paid (1,936) (1,850)

Other — (175)

Benefit obligation at end of year 53,551 50,154

Change in plan assets:

Fair value of plan assets at

beginning of year 44,096 42,286

Actual return on plan assets 2,369 2,725

Employer contributions 1,600 764

Plan participants’ contributions 220 171

Benefits paid (1,936) (1,850)

Fair value of plan assets at end of year 46,349 44,096

Funded status (7,202) (6,058)

Unrecognized actuarial losses 5,068 6,904

Unrecognized prior service cost 2,028 966

Unrecognized transitional obligation 417 521

Prepaid pension costs $ 311 $ 2,333

The projected benefit obligation for domestic plans is deter-

mined using an assumed weighted average discount rate of

8.25% at May 31, 2000 and 7.5% at May 31, 1999, and an

assumed average compensation increase of 5.0%. The expected

long-term rate of return on assets is 10.0% for fiscal 2000 and

1999. The unrecognized actuarial losses, prior service cost and

transition obligation are amortized on a straight-line basis over

the estimated average future service period.

The projected benefit obligation for nondomestic plans is

determined using an assumed weighted average discount rate

of 6.5% at May 31, 2000 and 5.5% at May 31, 1999, and

an assumed average compensation increase of 4.0%. The

expected long-term rate of return on assets is 6.5% for fiscal

2000 and 1999.

Pension expense charged to results of operations includes the

following components:

May 31, 2000 1999 1998

Service cost $ 2,647 $ 2,315 $ 1,643

Interest cost 3,791 3,334 3,011

Expected return on plan assets (3,881) (3,560) (3,165)

Amortization of prior service cost 169 138 138

Recognized net actuarial loss 411 412 173

Transitional obligation 90 92 93

$ 3,227 $ 2,731 $ 1,893

Defined Contribution Plan

The defined contribution plan is a profit sharing plan which

is intended to qualify as a 401(k) plan under the Internal

Revenue Code. Under the plan, employees may contribute up

to 15.0% of their pretax compensation, subject to applicable

regulatory limits. The Company may make matching contri-

butions up to 6.0% of compensation. Participants vest on a

pro-rata basis in Company contributions during the first three

years of employment. Expense charged to results of operations

was $1,634, $1,491 and $1,174 in fiscal 2000, 1999 and

1998, respectively.

Director, Executive and Key Employee Retirement

Benefit and Profit Sharing Plans

The Company provides its outside directors with benefits upon

retirement on or after age 65 provided they have completed at

least five years of service as a director. Benefits are paid quar-

terly in cash in an amount equal to 25.0% of the annual

retainer fee payable by the Company to active outside direc-

tors. Payment of benefits commences upon retirement and

continues for a period equal to the total number of years of

the retired director’s service as a director to a maximum of ten

years, or death, whichever occurs first.

The Company also provides supplemental retirement and

profit sharing benefits for current and former executives and

key employees to supplement benefits provided by the

Company’s other benefit plans. The plans are not fully funded

and may require funding in the event of a change in control

of the Company as determined by the Company’s Board of

Directors. Expense charged to results of operations for these

plans was $345, $1,162 and $1,231 in fiscal 2000, 1999 and

1998, respectively.

39

Postretirement Benefits Other Than Pensions

The Company provides health and life insurance benefits

for certain eligible employees and retirees under a variety of

plans. Generally these benefits are contributory with retiree

contributions adjusted annually. The postretirement plans are

unfunded, and the Company has the right to modify or termi-

nate any of these plans in the future, in certain cases, subject

to union bargaining agreements. In fiscal 1995, the Company

completed termination of postretirement healthcare and life

insurance benefits attributable to future services of collective

bargaining and other domestic employees.

Postretirement benefit cost for the years ended May 31, 2000,

1999 and 1998 included the following components:

May 31, 2000 1999 1998

Service cost $ — $— $ —

Interest cost 104 96 89

$104 $96 $89

The funded status of the plans at May 31, 2000 and 1999

was as follows:

May 31, 2000 1999

Change in benefit obligations:

Benefit obligations at beginning of year $ 1,463 $ 1,354

Interest cost 104 96

Benefits paid (153) (240)

Unrecognized actuarial loss (57) 108

Plan participants’ contributions — 145

Benefit obligation at end of year 1,357 1,463

Change in plan assets:

Fair value of plan assets at

beginning of year — —

Company contributions 153 95

Benefits paid (153) (240)

Plan participants’ contributions — 145

Fair value of plan assets at end of year — —

Funded status (1,357) (1,463)

Unrecognized actuarial (gains) losses (3) 53

Unrecognized prior service cost 160 210

Accrued postretirement costs $(1,200) $(1,200)

The assumed discount rate used to measure the accumulated

postretirement benefit obligation was 8.25% at May 31, 2000

and 7.5% at May 31, 1999. The assumed rate of future increases

in healthcare costs was 6.8% and 7.5% in fiscal 2000 and 1999,

respectively, declining to 5.25% by the year 2004 and remaining

at that rate thereafter. A one percent increase in the assumed

healthcare cost trend rate would increase the accumulated postre-

tirement benefit obligation by approximately $44 as of May 31,

2000 and would not result in a significant change to the annual

postretirement benefit expense.

7. COMMITMENTS AND CONTINGENCIES

The Company leases certain facilities and equipment under

agreements which are accounted for as operating leases that

expire at various dates through 2011. The Company also leases

certain aviation equipment which are accounted for as operat-

ing leases. The terms of these arrangements are one to five

years with options to renew annually at the election of the

Company. If the Company elects to not renew the lease, the

Company is required to purchase the aviation equipment at its

stipulated lease value. The Company may also sublease the avi-

ation equipment to a customer on a short- or long-term basis.

Future minimum payments under leases with initial or remain-

ing terms of one year or more at May 31, 2000 are as follows:

Facilities and AviationYear Equipment Equipment

2001 $5,682 $ 2,787

2002 4,343 2,787

2003 3,621 2,787

2004 3,243 2,787

2005 and thereafter 3,639 20,117

Rental expense during the past three fiscal years was as follows:

May 31, 2000 1999 1998

Facilities and Equipment $9,663 $8,339 $6,991

Aviation Equipment 8,344 4,242 422

The Company routinely issues letters of credit, performance

bonds or credit guarantees in the ordinary course of its busi-

ness. These instruments are typically issued in conjunction with

insurance contracts or other business requirements. The total of

these instruments outstanding at May 31, 2000 was approxi-

mately $51,500.

The Company is involved in various claims and legal actions,

including environmental matters, arising in the ordinary course

of business. In the opinion of management, the ultimate dis-

position of these matters will not have a material adverse effect

on the Company’s consolidated financial condition or results

of operations.

40

8. INVESTMENT IN LEVERAGED LEASES

From time to time, the Company acquires aircraft under lease

that qualify for leveraged lease accounting treatment. Typically,

these are long-term leases of late-model aircraft operated by

major carriers where the Company is an equity participant of

at least 20% and there is a third-party provider of nonrecourse

debt of the remaining equipment cost.

During the lease term the Company is required, in accordance

with SFAS No. 13, to adjust the elements of the investment in

leveraged leases to reflect changes in important economic

assumptions, such as the renegotiating of the interest rate on the

nonrecourse debt or changes in income tax rates. In addition,

the Company may sell options or other rights to the residual

proceeds over the book value at the end of the lease term.

The Company’s net investment in leveraged leases is comprised

of the following elements:

for the year ended May 31, 2000 1999

Rentals receivable (net of principal and

interest on the nonrecourse debt) $ 15,488 $ 15,681

Estimated residual value of

leased assets 32,952 32,952

Unearned and deferred income (13,953) (14,580)

34,487 34,053

Deferred taxes (27,120) (27,440)

Net investment in leveraged leases $ 7,367 $ 6,613

Pretax income from leveraged leases was $695, $702 and

$1,329 in fiscal 2000, 1999 and 1998, respectively.

9. OTHER NONCURRENT ASSETS

At May 31, 2000 and 1999, other noncurrent assets consisted

of the following:

May 31, 2000 1999

Investment in joint ventures $22,811 $18,509

Notes receivable 7,822 7,130

Prepaid pension costs 311 2,333

Cash surrender value of life insurance 2,719 1,884

Debt issuance costs 818 1,028

Other 11,920 9,402

$46,401 $40,286

10. ACQUISITIONS

On October 19, 1998, the Company acquired substantially

all of the assets and assumed certain liabilities of Tempco

Hydraulics Inc. (Tempco), a regional aircraft landing gear repair

and overhaul business. The purchase price of approximately

$7.5 million was paid with a combination of cash and a note.

The transaction was recorded under the purchase method of

accounting. The Company has included in its consolidated

financial statements the results of operations of Tempco since

the date of acquisition.

On December 31, 1997, the Company acquired substantially

all of the assets and assumed certain liabilities of AVSCO

Aviation Service Corporation (AVSCO), a distributor of factory-

new parts and accessories to the commercial, regional/commuter

and general aviation markets. The purchase price of approxi-

mately $18.4 million was paid with a combination of cash and

a note, and the transaction was recorded under the purchase

method of accounting. The Company has included in its con-

solidated financial statements the results of operations of

AVSCO since the date of acquisition.

On October 24, 1997, the Company purchased the stock of

ATR International, Inc. (ATR), a company which engineers and

manufactures composite parts and structures for the aviation/

aerospace industry. The Company acquired ATR for approxi-

mately $19 million cash, and the transaction was recorded

under the purchase method of accounting. The Company has

included in its consolidated financial statements the results of

operations of ATR since the date of acquisition.

On June 2, 1997, the Company acquired substantially all of the

assets and assumed certain liabilities of Cooper Aviation

Industries, Inc. (Cooper), a distributor of factory-new aviation

parts and accessories to the commercial, regional/commuter

and general aviation markets. The purchase price was paid by

issuing 140 thousand common shares (adjusted for the three-

for-two stock split) and was recorded under the purchase

method of accounting. In addition, the Company assumed

short-term debt which was paid off by the Company during

the first quarter of fiscal 1998. The Company has included in

its consolidated financial statements the results of operations

of Cooper since the date of acquisition.

The historical operating results of the acquisitions for the

periods preceding the acquisitions are not material when com-

pared to the operating results of the Company.

41

11. BUSINESS SEGMENT INFORMATION

The carrying value of long-lived assets in Company facilities

located in foreign countries, and sales from these facilities in

total, are not material to the consolidated financial statements.

Export sales from the Company’s U.S. operations to unaffili-

ated customers, the majority of which are located in Europe,

the Middle East, Canada, Mexico, South America and Asia

(including sales through foreign sales offices of domestic sub-

sidiaries), were approximately $184,718 (18.0% of total sales),

$209,712 (20.0% of total sales) and $202,481 (23.6% of total

sales) in fiscal 2000, 1999 and 1998, respectively.

Sales to the U.S. Government, its agencies and its contrac-

tors were approximately $132,048 (12.9% of total sales),

$98,954 (9.4% of total sales) and $83,114 (9.7% of total

sales) in fiscal 2000, 1999 and 1998, respectively. Sales to the

Company’s largest customer, excluding pass through sales, were

$114,000 and $135,100 during fiscal 2000 and 1999, respec-

tively. Including pass through sales, sales to the largest

customer were $180,800 and $267,000 during fiscal 2000 and

1999, respectively. No assurances can be given that sales to this

customer will continue at historical levels in the future.

12. ALLOWANCE FOR DOUBTFUL ACCOUNTS

for the year ended May 31, 2000 1999 1998

Balance, beginning of year $ 4,830 $ 3,157 $ 1,965

Provision charged

to operations 5,470 2,902 1,261

Reserves acquired — — 1,679

Deductions for accounts

written off, net of recoveries (220) (1,229) (1,748)

Balance, end of year $10,080 $ 4,830 $ 3,157

42

TO THE STOCKHOLDERS AND BOARD OFDIRECTORS OF AAR CORP.:

We have audited the accompanying consolidated balance

sheets of AAR CORP. and subsidiaries as of May 31, 2000

and 1999, and the related consolidated statements of income,

stockholders’ equity and cash flows for each of the years in

the three-year period ended May 31, 2000. These consolidated

financial statements are the responsibility of the Company’s

management. Our responsibility is to express an opinion on

these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards

generally accepted in the United States of America. Those stan-

dards require that we plan and perform the audit to obtain

reasonable assurance about whether the financial statements are

free of material misstatement. An audit includes examining, on

a test basis, evidence supporting the amounts and disclosures in

the financial statements. An audit also includes assessing the

accounting principles used and significant estimates made by

management, as well as evaluating the overall financial state-

ment presentation. We believe that our audits provide a

reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred

to above present fairly, in all material respects, the financial posi-

tion of AAR CORP. and subsidiaries as of May 31, 2000 and

1999, and the results of their operations and their cash flows

for each of the years in the three-year period ended May 31, 2000

in conformity with accounting principles generally accepted in

the United States of America.

KPMG LLP

Chicago, Illinois

June 27, 2000

CORPORATE HEADQUARTERS

One AAR Place

1100 North Wood Dale Road

Wood Dale, Illinois 60191

Telephone: (630) 227-2000

Facsimile: (630) 227-2019

www.aarcorp.com

TRANSFER AGENTS AND REGISTRARS

First Chicago Trust Company of New York

Jersey City, New Jersey

ANNUAL MEETING OF STOCKHOLDERS

The annual meeting of stockholders will be held October 11,

2000 at 3:00 p.m. (CDT) at Bank of America Illinois

Shareholders Room (21st Floor), 231 South LaSalle Street,

Chicago, Illinois 60604.

The number of holders of common stock, including partic-

ipants in security positions listings as of June 30, 2000, was

approximately 11,000.

STOCKHOLDERS’ DIVIDEND REINVESTMENT SERVICE PLAN

AAR CORP. provides its stockholders the opportunity to pur-

chase additional shares of common stock of the Company by

automatic reinvestment of dividends and optional additional

investments. Stockholders may obtain information regarding this

plan by writing the Secretary, AAR CORP., One AAR Place,

1100 North Wood Dale Road, Wood Dale, Illinois 60191.

SPECIAL COUNSEL

Schiff Hardin & Waite

Chicago, Illinois

TICKER SYMBOL

AAR stock is traded on the New York and Chicago Stock

Exchanges. Ticker symbol AIR.

43

Independent Auditors’ Report Stockholder Information

AUDIT

Joel D. Spungin

Chairman

A. Robert Abboud

Howard B. Bernick

Erwin E. Schulze

COMPENSATION

Erwin E. Schulze

Chairman

A. Robert Abboud

Edgar D. Jannotta

Lee B. Stern

EXECUTIVE

Ira A. Eichner

Chairman

Edgar D. Jannotta

Erwin E. Schulze

David P. Storch

NOMINATING

David P. Storch

Chairman

Ira A. Eichner

Lee B. Stern

Richard D. Tabery

David P. Storch

President and Chief Executive Officer

Philip C. Slapke

Executive Vice President, Asset Management & Services Group

Michael K. Carr

Vice President, Tax

Peter K. Chapman

Vice President, Marketing and Business Development

James J. Clark

Vice President, Component Repair & Service

A. Lee Hall

Vice President, Strategic Planning and Acquisitions

Douglas S. Hara

Vice President, Purchasing and Facilities

John C. Mache

Vice President, Electronic Commerce

J. Steven McConnell

Vice President, Asset Management & Trading

Roberta R. McQuade

Vice President, Human Resources

David E. Prusiecki

Vice President, Defense Programs

Howard A. Pulsifer

Vice President, General Counsel and Secretary

Timothy J. Romenesko

Vice President and Chief Financial Officer

Michael J. Sharp

Vice President, Controller and Chief Accounting Officer

James N. Vincent

Vice President, Aircraft Turbine Center

44

Board Committees Corporate Officers

1100 North Wood Dale RoadWood Dale, Illinois 60191